Tax Court Determines Value of Interests in Artwork for Estate Tax Purposes

In Estate of Elkins v. Commissioner, the Tax Court rejected the IRS's argument that no discount should be allowed in valuing fractional interests in artwork in a decedent's estate. The Court, however, allowed only a ten percent discount to account for uncertainties a purchaser might encounter in selling the fractional interests to the cotenants, the decedent's children.

The decedent and his spouse amassed a collection of art over a thirty year period. The wife's community interest in the remaining artwork passed to her husband under her will, but he disclaimed an undivided 26.9% interest in order to fund the wife's exemption. As a result, each of the three children received an undivided 8.98% interest in each of those pieces and the decedent retained an undivided 73.055% interest.

The children and the decedent entered into a cotenants' agreement, providing, among other things, that any of the artwork could be sold only with the unanimous consent of all cotenants. Any sale would be distributed pro rata, according to the respective percentage interests of the cotenants. The undiscounted value of the artwork was $36.2 Million.

On the estate tax return, the decedent's executor claimed a fractional interest discount of 44.75% for lack of control and marketability. The IRS argued no discount should be allowed, because the agreement not to partition the artwork was a "restriction on the right to sell," which under Section 2703(a)(2) is to be disregarded in valuing property in a decedent's estate. The law allows for an exception where the terms of the restriction are "comparable to similar arrangements entered into by persons in an arms' length transaction." Because the parties involved were siblings, the executor in this case conceded they were not comparable to persons in an arm's length transaction

The estate presented three experts who testified that the most likely purchaser of a fractional interest would be a speculator who would seek a partition despite the restriction, and thus argued for very deep discounts on most of the artwork.

The IRS presented two experts, one of whom testified that there was no market in fractional interests in art, while the other testified that the agreement not to partition was not typical of arms' length transactions, a point the estate had conceded.

The estate's valuation testimony was premised on the idea that the decedent's children would resist partition, seeking to keep the art in the family. The IRS argued that this consideration was irrelevant under Treas. Reg. Sec. 20.2031-1(b), which requires that property in a decedent's estate be valued at the price at which it would be exchanged between an entirely hypothetical willing buyer and willing seller.

The Court sided with the estate, saying the regulation "should not be read in a vacuum, without reference to actual circumstances." A potential buyer would take title to the fractional interests in the artwork knowing the decedent's children also held undivided fractional interests, and knowing the children did not desire a partition.

The Court concluded the parties in such a sales scenario would likely negotiate a price "at or fairly close to the pro rata fair market value of [the decedent's fractional] interests." The Court, however, acknowledged the hypothetical buyer might insist on at least a nominal discount, which the Court set at ten percent of the fair market value.

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